Consumer and producer surplus - Chapter 4 - ECON100

The analysis of consumer and producer surplus helps us calculate

How much benefit the producers and consumers receive

Consumer surplus

A consumers’ willingness to pay for a good at its maximum price which they would by that good

Individual consumer surplus

The gain to an individual buyer from the purchase of a good; the difference between the price paid vs. what the consumer is willing to pay

Total consumer surplus

The sum of individual consumer surpluses of all the buyers in a market 

Producer surplus

The difference between market price and the price at which firms are willing to supply the product

Individual producer surplus

The net gain to an individual seller from selling a good. It. is equal to the difference between the price received and the seller’s cost (seller’s cost includes monetary cost and may also include opportunity cost

Total producer surplus

The sum of individual producer surpluses of all the sellers in the market 

Total surplus

The sum of the producer and consumer surpluses

Price controls

Legal restrictions on how high or low a market price may go

two main types:

Price ceiling

Price floor

Price ceiling (price controls)

A maximum price sellers are allowed to charge for a good or service (usually set below equilibrium)

Price floor (price controls)

A minimum price buyers are required to pay for a good or service (usually set above equilibrium)

How price ceilings cause inefficiency

Inefficiently low quantity

Inefficient allocation to customers

Wasted resources

Inefficiently low quality

Black markets

Inefficient allocation to customers (How price ceilings cause inefficiency)

Price control leads to misallocation of apartments; people who badly need one might not get one. But some people who have them may have less urgent needs. 

Under rent control, people get apartments through luck or personal connections. 

Wasted resources (How price ceilings cause inefficiency)

People expend money, effort, and time to cope with shortages caused by price ceilings 

The opportunity cost of the time spent in lines- the wages not earned- leisure time not enjoyed 

Rent control creates missed opportunities 

Inefficiently low quality (How price ceilings cause inefficiency)

At the controlled price, sellers have more customers than goods

In a free market, this would be an opportunity to profit by raising prices, but when prices are controlled, sellers cannot raise prices

Sellers respond in 2 ways: reduce quality, reduce service

Black market (How price ceilings cause inefficiency)

A market in which goods or services are bought and sold illegally

Why are there price ceilings

They do benefit some people: those who are more organized and vocal

If the price ceiling has been in effect for a long time, buyers may not have a realistic idea of what would happen without it

How a price floor causes inefficiency

Deadweight loss

Inefficient allocation of sales among sellers

Waste of resources

Inefficiently high quality

Temptation to break the law by selling below the legal price

Deadweight loss (how price floors cause inefficiency)

A price floor reduces the quantity demanded below the market equilibrium quantity and leads to a deadweight loss.

Price controls typically create this

Inefficient allocation of sales among sellers (how price floors cause inefficiency)

Price floors misallocate sales by:

• Allowing high-cost firms to operate.

• Preventing low-cost firms from entering the industry.

Wasted resources (How price floors cause inefficiency)

Price floors encourage waste
To deal with the surplus generated by dairy price floors, the government buys back the excess, donates it, or gets rid of it.

Inefficiently high quality (how price floors cause inefficiency) 

Price floors encourage sellers to offer goods of inefficiently high quality—the quality that is higher than buyers are willing to pay for.

Illegal activity (how price floors cause inefficiency)

Price floors encourage black markets. There are willing sellers (and buyers) at illegal prices, so they are tempted to break the law and trade with each other.

Why are there price floors?

They do benefit some people (who are typically better organized and more vocal than those who are harmed by them).

Government officials often do not understand supply and demand analysis.

Price ceilings and floors typically 

Change quantities along existing curves